The bill contains complex and rather vague definitions as to which activities qualify for the super tax deduction.
Under existing rules, taxpayers only qualify for a 100% tax deduction on any R&D expenditure incurred to its business, subject to satisfying certain conditions. The R&D expenditure must be incurred in respect of R&D activities undertaken by the taxpayer itself or paid to an approved research institution.
The bill, however, broadly classifies R&D expenditure in two broad categories (Type A and Type B expenditures) that are deductible subject to meeting certain conditions. Type A qualifies for a basic 100% tax deduction. It is Type B expenditure that qualifies for the enhanced two-tiered tax deduction (300% tax deduction for the first HK$2 million ($255,000) and 200% for the remaining amount).
The critical element to qualify for Type B expenditure is that the R&D activity is wholly undertaken in Hong Kong and is one of the following:
- An activity in the fields of natural or applied science to extend knowledge;
- Any original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding; or
- The application of any research finding or other knowledge to a plan or design for producing or introducing new or substantially improved materials, devices, products, processes, systems or services before they are commercially produced or used.
However, the bill excludes certain activities from qualifying as Type B expenditure, including:
- Any efficiency survey, feasibility study, management study, market research or sales promotion;
- The application of any publicly available research findings or other knowledge to a plan or design, with an anticipated outcome and without any scientific or technological uncertainty;
- Any activity that does not seek to directly contribute to achieving an advance in science or technology by resolving scientific or technological uncertainty; or
- Any work to develop the non-scientific or non-technological aspect of a new or substantially improved material device, product, process, system or service.
In order for expenditure on a qualifying R&D activity to qualify for the super tax deduction, it must be incurred in relation to the taxpayer's business and must be:
- Paid to a designated local research institution; or
- Paid to a designated local research institution which has, as an object, the undertaking of a qualifying R&D activity related to the class of business to which the taxpayer's business belongs, where the payment is used for pursuing that object; or
- An expenditure in relation to: (i) an employee engaged directly and actively in a qualifying R&D activity; or (ii) a consumable item that is used directly in a qualifying R&D activity.
Again, there are some key exclusions where no R&D deduction is allowed. This includes where the R&D expenditure is undertaken for another person, any rights generated from the R&D activity are not fully vested in the person, or the costs are met by the government or another person.
This is another welcome tax incentive that will provide Hong Kong with a competitive advantage in promoting R&D activities to be carried out in Hong Kong. There are, however, potentially onerous and complex conditions that need to be satisfied in order to qualify for the super tax deduction.
In our experience, many companies will find that they are conducting quality R&D activities as part of their product and process improvement activities. To ensure that they are in a position to claim the new benefit, it will be vital that they have the systems and processes in place to correctly identify projects and classify their R&D expenditure.
|Lewis Lu||Curtis Ng|